How to start investing

Zemanta Related Posts ThumbnailA reader recently posted this question on my Facebook page:

Liz, I’m 30 years old and looking into starting [to invest in] mutual funds and IRAs and have no idea where to start. I know I really need to invest for the future and am eager to do so, but again, have no knowledge on any of this nor know where to start. Any advice or pointers would be more than appreciated.

I suggested he start with reading two really good books for beginning investors, Kathy Kristof’s “Investing 101” and Eric Tyson’s “Personal Finance for Dummies.” But here’s a summary of what you’ll learn:

Get started investing as soon as possible, even if you don’t quite know what you’re doing. You’ll learn along the way, and you really can’t make up for lost time.

Invest mostly in stocks. Stocks over time offer the best return of any investment class, and provide you the inflation-beating gains you’ll need for a comfortable retirement.

Don’t try to beat the market. Few do consistently. Most people just waste a lot of money. Instead, opt for mutual funds or exchange traded funds that try to match the market, rather than beat it.

Keep fees low, low, low. Wall Street loves to slather them on, but fees kill returns. Here’s an example: An annual IRA contribution of $5,000 can grow to about $1 million over 40 years if you net a 7 percent average annual return. If you net 6 percent, that lowers your total by a $224,000. That’s a heck of a lot to pay for a 1 percentage point difference in fees.

If you have a workplace retirement plan such as a 401(k), that’s where you should start investing. If you don’t, then an IRA you open yourself is the next best thing.

So here’s a prescription for getting started: Open an IRA at Vanguard, which prides itself on its low expenses. Send them a check for $1,000 (the minimum to get started with an IRA). Choose a target date retirement fund that’s close to the year when you expect to retire (in this reader’s case, that would be the Vanguard Target Retirement 2050). Target date funds take care of everything: asset allocation, investment choices, rebalancing over time for a more conservative mix as you approach retirement age. You can get the $20 annual account fee waived if you sign up for online access and opt for electronic delivery of account documents.

There you go–you’re on your way.

Investing in stocks: what you need to know

Dear Liz: I currently have a 401(k) and an IRA, but want something more. A longtime CPA, who is very close to our family, recommended that I buy some stocks, but I’m unsure how to go about this.

Answer: When you’re investing, it’s important to be diversified. That means you should spread your money among different types of investments so you don’t have all your eggs in one basket, so to speak.

You’d need hundreds of thousands of dollars to be properly diversified with individual stocks. When you’re just starting out, it’s a lot smarter to buy mutual funds or exchange-traded funds that invest in a wide variety of stocks. Vanguard Total Stock Market ETF, for example, invests in more than 3,600 companies and has an ultra-low expense ratio of just 0.05%.

The fees you pay for your investments are important, since high expenses can dramatically reduce your total returns. Funds that try to beat the market, rather than match it, often engage in a lot of trading that drives up costs. Funds sold through full-service brokerages can carry high expenses as well.

So look for a discount brokerage that allows you to invest with minimal fees and commissions. Or consider one of the new breed of online advisors, such as Betterment or Wealthfront, that offers a low-cost basket of investments that are selected, monitored and rebalanced using sophisticated technology.

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Stick to an investment plan for best results

Dear Liz: If I plan to stay invested for more than 15 years and I can tolerate the ups and downs of the market, why would I want to put any of my 401(k) money into bonds instead of putting it all in various stock funds? The bond funds in my 401(k) have a five-year return of 5% to 6% whereas the other funds are 8% to 13%.

Answer: If you look at the more recent performance of those bond funds, you’ll notice that their returns are considerably worse. Many have been losing money lately as interest rates have risen. That poor performance may worsen if the economy improves and rates continue to rise.

But you need to consider more than recent performance when allocating your portfolio. Bonds and cash can cushion your account against big downturns in the stock market. That can help keep you from panicking and selling at a bottom.

If you’re as risk tolerant as you think and decades away from retirement, you might be able to put as little as 10% of your portfolio into bonds and cash. If you’re 15 to 20 years from retirement, a 20% bond allocation may be more prudent. A fee-only financial planner can help advise you about sensible asset allocations, or you can check out the stock and bond mixes of target date funds offered by leading mutual fund companies (such as the Vanguard Target Retirement 2030 Fund, if you’ll be retiring around 2030).